ESG Investing Rule Holds (For Now)

The challenge to what is often shorthanded as the 2022 ESG rule may come later. Or the new administration may simply choose not to enforce it.

ERISA fiduciary duty lawsuit

In June 2023, Bryan Spence, an American Airlines pilot and participant in the pilot’s plan filed a class action lawsuit against both American Airlines and its employee benefits committee alleging they violated their fiduciary duties of prudence and loyalty under ERISA. The lawsuit claims that fiduciaries broke the law by retaining and failing to monitor BlackRock as a third-party investment manager. BlackRock was well-known for its campaign to use its shareholder proxy voting power in publicly held companies to promote pro-ESG initiatives.

At the heart of the complaint was the accusation that the fiduciaries had failed in their legal duty under Section 404 of ERISA to:

• exercise financial prudence in selecting plan investments; and
• act exclusively in the interest of plan participants and beneficiaries.

When the complaint was filed, some saw the lawsuit as an attempt to challenge the 2022 ESG rule under the brewing Loper Bright challenges to the power of the DOL to issue regulations concerning matters not specifically addressed in the language of ERISA.
But that is not entirely what happened.

Three pieces of legal guidance to watch simultaneously  

The first piece, ERISA Section 404(a)(1)(A) requires that fiduciaries:

“discharge [their] duties with respect to a plan solely in the interest of the participants and beneficiaries and—
(A ) for the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries; and
(ii) defraying reasonable expenses of administering the plan.”

Commonly known as the “exclusive benefit” rule, this explicitly prohibits decisions that balance the needs of participants and, for example, the plan sponsor.

The second piece, subsection (B) of the same section, requires that fiduciaries act:

“with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

Often referred to as the “prudent person” rule, this section goes on to describe the need to diversify investments to minimize losses and to operate the plan in accordance with plan documents. Case law has firmly established that prudence also includes a continuing duty to monitor the performance of investments and investment managers to whom decisions have been delegated.

The third piece, the DOL Regulation entitled, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights was published in the Federal Register on December 1, 2022. In brief, it permits fiduciaries to consider “the economic effects of climate change” and other ESG factors when making investment decisions, as long as the considerations remain rooted in the typical risk-reward analysis generally required by the legal standard. ESG factors can be used as a tie-breaker when all the other factors are equal.

The 2022 rule has been highly controversial, especially when considered in the light of the “prudent person” rule, and this potential conflict is where many expected the Northern District to focus. Instead, the lens through which it viewed the conflict was the “exclusive benefit” rule.

Incestuous relationship

As the same court’s 2024 decision denying the defendants’ motion for summary judgment points out, there was troubling evidence that the plan fiduciaries never reviewed or monitored proxy voting by any of the investment managers. This lack of review and monitoring even appears to have taken place after the defendants learned that BlackRock voted proxies in support of ESG objectives rather than exclusively in the financial best interests of the plan participants.

Furthermore, additional facts raise issues about potential conflicts of interest. For instance, the person responsible for monitoring investment managers also managed the corporate financial relationship with BlackRock, which held a significant equity stake in American Airlines. Even American Airline’s Director of Asset Management called “this whole ESG thing circular” because of BlackRock’s ownership of a substantial amount of the airline’s stock and fixed income debt at the same time it pursued ESG objectives with “$35 billion in assets” under its control.

Plaintiffs were unable to demonstrate that the failure of the fiduciaries to monitor BlackRock’s investment choices had done financial damage to the plan. It was difficult, therefore, to demonstrate that the investment choices had not been prudent, but they certainly seem to have flouted the exclusive benefit portion of the duty of loyalty to plan participants. This was the basis for the court’s decision that the fiduciaries had, in fact, violated ERISA Section 404’s requirements.